Check Fraud Litigation in Connecticut After the 1990 Revisions to the U.c.c
| Pages | 393 |
| Publication year | 2021 |
68 CBJ 393. Check Fraud Litigation in Connecticut After the 1990 Revisions to the U.C.C
For as long as people have used checks to transfer money some individuals have found ways to steal funds using checks. The usual result is a contest between two innocent parties over who should bear the loss from the fraud committed by a third. In most check fraud cases the plaintiff is the owner of the checking account involved in the fraud and is suing one or more of the banks which honored the checks in question. In larger cases the victim is usually a business which has been victimized by an employee who had access to its check processing system.
Check fraud litigation is governed by Articles 3 and 4 of the Uniform Commercial Code ("U.C.C." or the "Code"). While the Code's treatment of check fraud law is comprehensive, the first three decades of experience under the U.C.C. were not entirely satisfactory. Readers of the Code found it dense and confusing. Litigants found results unpredictable. Commentators found numerous points for debate about construction of the statute, highlighted by occasional conflicting interpretations in different jurisdictions.
In response to these concerns, and to a perceived need to modernize the statute, the Commissioners of Uniform Laws promulgated revisions to Articles 3 and 4 in 1990 (the "Revisions"). The Revisions were adopted in Connecticut in P.A. 91-304 and have been enacted so far in 36 other states. The Revisions do much to clarify the law and to resolve inconsistent interpretations among various courts. They also make some substantive changes to the law which have an important bearing on how check fraud disputes are resolved (fn1)
This article provides an overview of check fraud law, with a focus on the changes brought about by the Revisions (fn2) The
article starts with an introduction to how check frauds are perpetrated and discovered, followed by discussion of the principal causes of action and defenses employed in check fraud cases. This article focuses on Connecticut cases but will often refer to authorities in other jurisdictions, since they are persuasive in construing a uniform law. (fn3) The article concludes with observations regarding litigation strategies and some general comments regarding this area of the law.
The majority of check fraud cases arise when a thief gets possession of someone else's check, forges either the drawer's signature on the front of the check or the payee's endorsement on the reverse, and then deposits it in an account under the thief's control. (fn4) Thus, the thief interrupts the normal route followed by a check to divert it to the thief's own account. The thief may do this before a check is issued (e.g., stealing a blank check and filling it out), or by intercepting a check after it is issued.
To understand check fraud it helps to remember the usual route followed by a check and the role of each party to that process. This process is illustrated by this sequence of events:
DRAWER: Person on whose account the check is drawn. Signer of the check. Delivers check to pay money to:
PAYEE: The person to whose order the check is written on the front. Endorses the back of the check and deposits it in:
DEPOSITARY BANK: The first bank in the collection chain. Forwards the check for collection to:
DRAWEE BANK: The bank on which the check is drawn. Returns check to its customer, the drawer, in a monthly statement.
A. Typical Check Fraud Schemes
In the simplest check frauds the thief steals a blank check from the owner of an account (the drawer). The thief then forges the drawer's signature and makes the check payable to the thief. The thief then deposits the check in his or her account. Once the check clears (assuming no one discovers the fraud in time to stop payment) the thief can take the proceeds and spend them or disappear.
In a second common scheme the thief holds a job which includes responsibility for issuing checks. (For example, the thief approves invoices for payment.) The thief prompts the company to issue a check (e.g. by approving a phony invoice), then he gets possession of the check and forges the payee's endorsement and deposits the check in his own account.
A third common check fraud involves a thief who works inside the payee's business. In this case the thief steals the check after it is received by the payee. (This can happen, for example, when the thief works in the payee's mail room where checks are received, or in the department which processes checks received from customers.) The thief forges the endorsement of his or her employer, the payee, and deposits the check in his or her own account.
B. Common Elements of Check Fraud Cases
There are three features common to virtually every check fraud case discussed in this article. First, the thief has either disappeared or is judgment-proof (otherwise, the victim could recover the funds from the wrongdoer).
Second, each fraud discussed in this article involves either an unauthorized signature on the front of the check (where the drawer signs) or an unauthorized endorsement on behalf of the payee on the reverse.
Third, the great majority of check fraud cases involve a claim against one or more banks by a business (since frauds relating to personal checking accounts rarely involve enough money to reach litigation). (fn5)
C. Prevention and Discovery of Check Fraud
Many checks pass through the hands of persons other than the drawer and payee (such as bookkeepers, messengers, and postal workers), so there are many opportunities for misappropriation. But check fraud leaves a "paper trail" such as bank records which show what account the check was deposited in, and who took funds out of that account. Thus, a thief will generally not undertake a fraud unless the thief believes it will not be detected. This is especially true with extended check frauds, where the thief must be in a position not only to get possession of checks but also to conceal the fraud.
The way to avoid such extended check frauds is by separation of functions." In a business, no single employee should have complete control over the flow of funds. (fn6) A prudent business examines the route followed by both incoming and outgoing funds and makes sure that at least two people (preferably in two departments) are aware of every check and would know if it were misappropriated. This is generally accomplished by balancing the company's own bank account and by reconciling all incoming checks to the company's general ledger. Absent such precautions, many extended check frauds are discovered simply because they continue so long that a significant amount of money is missing. In a small business, a check fraud might be discovered when legitimate checks bounce. In a larger company, the fraud might be discovered when financial reviews show unusually low revenues or high expenses in one department or another.
Once the victim starts to investigate, it usually can see how the fraud occurred by following the checks' paper trail. Bank records will reflect not only the ownership of the account into which the check was deposited, but also the path followed by all funds out of that account when the thief later removed the funds. Moreover, banks make microfilm photocopies of the front and back of every check. The company can (at some expense) get microfilm copies of its own checks from its bank and compare those to its record of legitimate expenses. The company might also contact a customer who according to the victim's books has not paid an invoice, then find that the customer can
produce a canceled check reflecting that payment. The back of that check will show the thief's forgery of the named payee's endorsement.
Once the victim of a check fraud learns of the fraud and concludes that it will not be repaid by the thief, it usually looks to be made whole by the banks through which the fraudulent checks were deposited and paid. We will now turn to the law governing such claims, first by determining what parties may assert which check fraud claims, and against whom. This is followed by a review of the elements of their causes of action, then an examination of the defenses available to the banks.
A. Who Can Be The Plaintiff?
The drawer is the primary party entitled to assert a claim in most check fraud cases. Where the drawer's own signature is unauthorized, the drawer is clearly the victim; it is the one who has "standing" to sue. The drawer is also the victim where the drawer actually signed the check but unknowingly was induced by the thief to issue it to a fictitious payee (e.g., to pay a fake invoice). In these cases the drawer has lost its funds without paying any debt it owes.
Even when the check was properly issued to a real payee, if the check is stolen before reaching the payee, the drawer is still the only party with the right to sue. This is because until the payee receives the check, the drawer's obligation to pay the payee is not considered discharged. (fn7) The drawer must, therefore, pay twice, so it is the party who has suffered the loss. (In some cases the drawer will refuse to issue a second check, thereby forcing the payee to sue the drawer who then may implead the banks.) Only when the payee actually receives the check before the thief steals it is the payee the party with the standing to sue. (fn8)
A person who is neither drawer nor payee will have difficulty establishing a sufficient interest to bring an action over a check fraud. (fn9)
B. What Cause of Action?
The Revisions have created, in effect, two "tiers"...
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